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How many machines should the manager purchase initially

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A manager must decide how many machines of a certain type to buy. The machines will be used to manufacture a new gear for which there is increased demand. The manager has narrowed the decision of two alternatives: buy one machine or buy two. If only one machine is purchased and demand is more than it can handle, a second machine can be purchased at a later time. However, the cost per machine would be lower if the two machines were purchased at the same time.

  • The estimated probability of low demand is 0.30 and the estimated probability of high demand is 0.70.
  • The net present value associated with the purchase of two machines initially is $75000 if demand is low and $130000 if demand is high.
  • The net present value for one machine and low demand is $90000. If demand is high, there are three options. One option is to do nothing, which would have a net present value of $90000. A second option is to subcontract; that would have a net present value of $110000. The third option is to purchase a second machine. This option would have a net present value of $100000.

Question 1: How many machines should the manager purchase initially? Use a decision tree to analyse this problem.

Reference no: EM132561371

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